PUBLICATIONS
In an effort to attract new business to Virginia, the General Assembly enacted the Virginia Business Trust Act. For several years, this type of entity has been common in Massachusetts and Delaware. The Massachusetts Trust was a common law vehicle, and the statutory business trust was first established in Delaware. However, it was difficult, if not impossible, to import either of these entities into Virginia with any degree of certainty as to how they would be treated, both from tax and liability perspectives.
Its sponsors call the Virginia Business Trust authorized by the Act “state of the art”, combining simplicity in its formation with great flexibility in its operation. The statute (Va. Code § 13.1-1201, et. seq.) defines a business trust as an unincorporated business, trust, or association that:
(A) is governed by a governing instrument under which:
1. Property is or will be held, managed, administered, controlled, invested, reinvested, or operated by a trustee for the benefit of persons as are or may become entitled to a beneficial interest in the trust Property; or
2. Business or professional activities for profit are carried on or will be carried on by one or more trustees for the benefit of persons as are or may become entitled to a beneficial interest in trust property; and
(B) files Articles of Trust under §13.1-1212.
And what does §13.1-1 then 212 require be included in Articles of Trust? A name for the trust that satisfies the requirements of §13.1-1214, the address of its registered office, the name of its registered agent, and the address of its “principal office”. That’s it; Formation couldn’t be simpler. Flexibility is provided by the fact that, unlike statutes governing corporations, there are very few things that a trust either must do or can’t do. The parties literally make their own law by agreement.; For example: the trust documents may create multiple trustees with different responsibilities and obligations. They may name a managing trustee, responsible for the management of assets, and a depository trustee responsible for holding and distributing the assets. In addition, the trust may have multiple classes of assets, each with different trustees and different beneficial owners. The rights, benefits and liabilities of each class may be separate and distinct, and the trust may provide for the distribution of profits in unequal shares to its trustees and beneficiaries. The management of the business trust may delegated to a third party other than the trustee, such as the entity that contributed the assets to the business trust, or even to the beneficial owners. Having said that, I’ll now state the obvious—the parties must make their own law by agreement. One may establish a business trust by filling in the blanks on a form, but that will not take advantage of the incredible flexibility afforded by this entity. Although it may seem counter-intuitive, the more flexible an entity, the more of a lawyer’s time is required to tailor it to the particular needs of the client.
The trust is perpetual and provides for limited liability. In addition, it specifically employs the “process standard” for determining the liability of trustees; i.e., the trustee is not liable for what may turn out to be a bad decision if the trustee has gone through a certain process. This was already the law in Virginia under the Supreme Court’s interpretation of the business judgment rule (Va. Code § 13.1-690). In adopting §13.1-690, the General Assembly rejected § 830 of the Revised Model Business Corporation Act, which requires that a director not only discharge his duties in good faith, but also with the care that an ordinary prudent person in similar circumstances would exercise. In some states, notably Delaware, the “reasonably prudent person” standard has led to some fuzzy law. In Virginia, a director’s discharge of duties is not measured by what a reasonable person would do in similar circumstances or by the rationality of the ultimate business decision. The test is not whether a court would have reached a different substantive decision, but rather is a procedural test; i.e., whether the directors engaged in an informed decision making process and whether they did so in good faith. Willard v. Moneta Bldg. Supply, Inc., 258 Va. 140, 515 S.E.2d 277 (1999). The same standard will be applied to trustees of a business trust.
The Virginia Business Trust falls under the IRS “check-the-box” regulations adopted in 1997 (Treasury Regulation §301.7701 et seq.) which allow a taxpayer to establish the tax classification of an alternative entity such as a business trust. The taxpayer simply elects to receive either partnership or corporate tax treatment, regardless of whether the particular entity has the traditional corporate characteristics of continuity of life, transferability of interest, centralized management, and limited liability of owners.
In some other jurisdictions, business trusts are increasingly becoming the preferred entity for issuing mortgage backed securities, managing real estate investment trusts, and serving as a special purpose entity when structuring a financing transaction. So far that has not been the case in Virginia.